Drilling Down Schlumberger&rsquo;s Prospects

The oil-services giant has much better margins than its rival Halliburton, as well as a more positive outlook for the coming quarter, writes MoneyShow’s Jim Jubak, also ofJubak’s Picks.

Report softly, but carry a big stick at the conference call. That’s not advice from Teddy Roosevelt, but my description of the first-quarter earnings report Friday morning, April 20, from Schlumberger (SLB), and then its afternoon conference call.

The earnings report was very solid, and suggested that the slowdown in drilling in the North American land market would draw to a close in the second half of 2012 as expected. But it wasn’t until the conference call that it became how definitely the current oil market is playing to Schlumberger’s strengths.

(The first quarter is a seasonally weak quarter because winter weather slows drilling and exploration, so earnings and revenue both fell sequentially in the first quarter from the fourth quarter of 2011.)

What was interesting to me about the conference call is how much more bullish Schlumberger sounded than Halliburton (HAL), the competitor that reported first-quarter results on April 18.

For example, Halliburton estimated that its North American operating margins will fall 2 to 2.5 percentage points in the second quarter. But Schlumberger didn’t lower its forecasts for second-quarter margins in North America. Reading between the lines, I’d conclude that Schlumberger is further along than Halliburton in switching to oil projects from natural gas.

Internationally, Schlumberger reported margins of 19.1%. That beat the Wall Street consensus projection of 18%, and was massively better than the 12.7% international margin at Halliburton. Pricing on contracts for standard technology “remained competitive,” Schlumberger reported, but “pricing sentiments” are moving upward on the majority of large international contracts.

“Service capacity is tightening further,” the company noted. From that, I think you can conclude that Schlumberger sees prices continuing to rise. Schlumberger projects that international rig count will increase by 10% in 2012.

When I last posted on Schlumberger on March 28, I warned that the company was likely to miss first-quarter earnings estimates—instead, Schlumberger matched estimates—and that the stock could fall to $64 to $65. At that price, I wrote, the shares would be priced to discount the weakness in the North American market.

For the moment, at least, it looks like I’ve missed my chance at that entry point. The shares were up 2.7% on Friday, to $71.70, although they’ve pulled back just a tad to $71.64 as of 1 p.m. New York time today.

But I wouldn’t throw in the towel and just buy at today’s price. Oil prices—or at least the price for Brent crude—are showing signs of weakness. The North American drilling market isn’t getting worse than expected, but the land market is still struggling.

There’s plenty of volatility around—in case you haven’t noticed—to suggest that you could still easily get Schlumberger below $70, and perhaps as low as $67 (or even $65) on the next ripples in the oil market or on the next spike of fear in Europe. Waiting for the pullback seems reasonable.

I’ve got a 12-month target price of $90 for these shares. With that target and this degree of market volatility, I’d sure like to buy below $70.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. The fund did own shares of Polypore International as of the end of September. For a full list of the stocks in the fund as of the end of September see the fund’s portfolio here.